PROBLEM 5–21 Sales Mix; Multiproduct Break-Even Analysis LO5–9
Gold Star Rice, Ltd., of Thailand exports Thai rice throughout Asia. The company grows three varieties of rice—White, Fragrant, and Loonzain. Budgeted sales by product and in total for the coming month are shown below:
Product
White Fragrant Loonzain Total
Percentage of total sales . . . 20% 52% 28% 100%
Sales . . . $ 150,000 100% $ 390,000 100% $ 210,000 100% $ 750,000 100%
Variable expenses. . . 108,000 72% 78,000 20% 84,000 40% 270,000 36%
Contribution margin . . . $ 42,000 28% $ 312,000 80% $ 126,000 60% 480,000 64%
Fixed expenses . . . . 449,280
Net operating income. . . . $ 30,720
Dollar sales to break-even = _____________Fixed expenses
CM ratio = ________$449,280 0.64 = $702,000
As shown by these data, net operating income is budgeted at $30,720 for the month and the estimated break-even sales is $702,000.
Assume that actual sales for the month total $750,000 as planned. Actual sales by product are:
White, $300,000; Fragrant, $180,000; and Loonzain, $270,000.
Required:
1. Prepare a contribution format income statement for the month based on the actual sales data.
Present the income statement in the format shown above.
2. Compute the break-even point in dollar sales for the month based on your actual data.
3. Considering the fact that the company met its $750,000 sales budget for the month, the presi- dent is shocked at the results shown on your income statement in (1) above. Prepare a brief memo for the president explaining why the net operating income (loss) and the break-even point in dollar sales are different from what was budgeted.
PROBLEM 5–22 CVP Applications; Contribution Margin Ratio; Break-Even Analysis; Cost Structure LO5–1, LO5–3, LO5–4, LO5–5, LO5–6
Due to erratic sales of its sole product—a high-capacity battery for laptop computers—PEM, Inc., has been experiencing financial difficulty for some time. The company’s contribution format income statement for the most recent month is given below:
Sales (19,500 units × $30 per unit) . . . $ 585,000 Variable expenses. . . 409,500 Contribution margin . . . 175,500 Fixed expenses . . . 180,000 Net operating loss. . . $ (4,500)
Required:
1. Compute the company’s CM ratio and its break-even point in unit sales and dollar sales.
2. The president believes that a $16,000 increase in the monthly advertising budget, combined with an intensified effort by the sales staff, will result in an $80,000 increase in monthly sales.
If the president is right, what will be the increase (decrease) in the company’s monthly net operating income?
3. Refer to the original data. The sales manager is convinced that a 10% reduction in the selling price, combined with an increase of $60,000 in the monthly advertising budget, will double unit sales. If the sales manager is right, what will be the revised net operating income (loss)?
4. Refer to the original data. The Marketing Department thinks that a fancy new package for the laptop computer battery would grow sales. The new package would increase packaging costs by 75 cents per unit. Assuming no other changes, how many units would have to be sold each month to attain a target profit of $9,750?
5. Refer to the original data. By automating, the company could reduce variable expenses by
$3 per unit. However, fixed expenses would increase by $72,000 each month.
a. Compute the new CM ratio and the new break-even point in unit sales and dollar sales.
b. Assume that the company expects to sell 26,000 units next month. Prepare two contribu- tion format income statements, one assuming that operations are not automated and one assuming that they are. (Show data on a per unit and percentage basis, as well as in total, for each alternative.)
c. Would you recommend that the company automate its operations? Explain.
PROBLEM 5–23 CVP Applications; Contribution Margin Ratio: Degree of Operating Leverage LO5–1, LO5–3, LO5–4, LO5–5, LO5–8
Feather Friends, Inc., distributes a high-quality wooden birdhouse that sells for $20 per unit. Vari- able expenses are $8 per unit, and fixed expenses total $180,000 per year. Its operating results for last year were as follows:
Required:
Answer each question independently based on the original data:
1. What is the product’s CM ratio?
2. Use the CM ratio to determine the break-even point in dollar sales.
3. If this year’s sales increase by $75,000 and fixed expenses do not change, how much will net operating income increase?
4. a. What is the degree of operating leverage based on last year’s sales?
b. Assume the president expects this year’s sales to increase by 20%. Using the degree of operating leverage from last year, what percentage increase in net operating income will the company realize this year?
5. The sales manager is convinced that a 10% reduction in the selling price, combined with a
$30,000 increase in advertising, would increase this year’s unit sales by 25%. If the sales man- ager is right, what would be this year’s net operating income if his ideas are implemented? Do you recommend implementing the sales manager’s suggestions? Why?
6. The president does not want to change the selling price. Instead, he wants to increase the sales commission by $1 per unit. He thinks that this move, combined with some increase in adver- tising, would increase this year’s sales by 25%. How much could the president increase this year’s advertising expense and still earn the same $60,000 net operating income as last year?
PROBLEM 5–24 Break-Even and Target Profit Analysis LO5–5, LO5–6
The Shirt Works sells a large variety of tee shirts and sweatshirts. Steve Hooper, the owner, is thinking of expanding his sales by hiring high school students, on a commission basis, to sell sweatshirts bearing the name and mascot of the local high school.
These sweatshirts would have to be ordered from the manufacturer six weeks in advance, and they could not be returned because of the unique printing required. The sweatshirts would cost Hooper $8 each with a minimum order of 75 sweatshirts. Any additional sweatshirts would have to be ordered in increments of 75.
Since Hooper’s plan would not require any additional facilities, the only costs associated with the project would be the costs of the sweatshirts and the costs of the sales commissions. The selling price of the sweatshirts would be $13.50 each. Hooper would pay the students a commission of
$1.50 for each shirt sold.
Required:
1. What level of unit sales and dollar sales is needed to attain a target profit of $1,200?
2. Assume that Hooper places an initial order for 75 sweatshirts. What is his break-even point in unit sales and dollar sales?
Sales . . . . $ 400,000 Variable expenses. . . . 160,000 Contribution margin . . . . 240,000 Fixed expenses . . . . 180,000 Net operating income. . . . $ 60,000
PROBLEM 5–25 Changes in Fixed and Variable Costs; Break-Even and Target Profit Analysis LO5–4, LO5–5, LO5–6
Neptune Company produces toys and other items for use in beach and resort areas. A small, inflat- able toy has come onto the market that the company is anxious to produce and sell. The new toy will sell for $3 per unit. Enough capacity exists in the company’s plant to produce 16,000 units of the toy each month. Variable expenses to manufacture and sell one unit would be $1.25, and fixed expenses associated with the toy would total $35,000 per month.
The company’s Marketing Department predicts that demand for the new toy will exceed the 16,000 units that the company is able to produce. Additional manufacturing space can be rented from another company at a fixed expense of $1,000 per month. Variable expenses in the rented facility would total $1.40 per unit, due to somewhat less efficient operations than in the main plant.
Required:
1. What is the monthly break-even point for the new toy in unit sales and dollar sales.
2. How many units must be sold each month to attain a target profit of $12,000 per month?
3. If the sales manager receives a bonus of 10 cents for each unit sold in excess of the break-even point, how many units must be sold each month to attain a target profit that equals a 25%
return on the monthly investment in fixed expenses?
PROBLEM 5–26 CVP Applications; Break-Even Analysis; Graphing LO5–1, LO5–2, LO5–4, LO5–5 The Fashion Shoe Company operates a chain of women’s shoe shops that carry many styles of shoes that are all sold at the same price. Sales personnel in the shops are paid a sales commission on each pair of shoes sold plus a small base salary.
The following data pertains to Shop 48 and is typical of the company’s many outlets:
Per Pair of
Shoes Selling price . . . . $30.00 Variable expenses:
Invoice cost . . . $13.50 Sales commission . . . . 4.50 Total variable expenses . . . . $18.00
Annual Fixed expenses:
Advertising . . . $ 30,000 Rent . . . 20,000 Salaries . . . 100,000 Total fixed expenses . . . $ 150,000
Required:
1. What is Shop 48’s annual break-even point in unit sales and dollar sales?
2. Prepare a CVP graph showing cost and revenue data for Shop 48 from zero shoes up to 17,000 pairs of shoes sold each year. Clearly indicate the break-even point on the graph.
3. If 12,000 pairs of shoes are sold in a year, what would be Shop 48’s net operating income (loss)?
4. The company is considering paying the Shop 48 store manager an incentive commission of 75 cents per pair of shoes (in addition to the salesperson’s commission). If this change is made, what will be the new break-even point in unit sales and dollar sales?
5. Refer to the original data. As an alternative to (4) above, the company is considering paying the Shop 48 store manager 50 cents commission on each pair of shoes sold in excess of the break-even point. If this change is made, what will be Shop 48’s net operating income (loss) if 15,000 pairs of shoes are sold?
6. Refer to the original data. The company is considering eliminating sales commissions entirely in its shops and increasing fixed salaries by $31,500 annually. If this change is made, what will be Shop 48’s new break-even point in unit sales and dollar sales? Would you recommend that the change be made? Explain.
PROBLEM 5–27 Sales Mix; Break-Even Analysis; Margin of Safety LO5–7, LO5–9
Island Novelties, Inc., of Palau makes two products—Hawaiian Fantasy and Tahitian Joy. Each product’s selling price, variable expense per unit and annual sales volume are as follows:
Fixed expenses total $475,800 per year.
Required:
1. Assuming the sales mix given above, do the following:
a. Prepare a contribution format income statement showing both dollar and percent col- umns for each product and for the company as a whole.
b. Compute the company’s break-even point in dollar sales. Also, compute its margin of safety in dollars and its margin of safety percentage.
2. The company has developed a new product called Samoan Delight that sells for $45 each and that has variable expenses of $36 per unit. If the company can sell 10,000 units of Samoan Delight without incurring any additional fixed expenses:
a. Prepare a revised contribution format income statement that includes Samoan Delight.
Assume that sales of the other two products does not change.
b. Compute the company’s revised break-even point in dollar sales. Also, compute its revised margin of safety in dollars and margin of safety percentage.
3. The president of the company examines your figures and says, “There’s something strange here. Our fixed expenses haven’t changed and you show greater total contribution margin if we add the new product, but you also show our break-even point going up. With greater contribution margin, the break-even point should go down, not up. You’ve made a mistake somewhere.” Explain to the president what has happened.
PROBLEM 5–28 Sales Mix; Commission Structure; Multiproduct Break-Even Analysis LO5–9
Carbex, Inc., produces cutlery sets out of high-quality wood and steel. The company makes a Stan- dard set and a Deluxe set and sells them to retail department stores throughout the country. The Standard set sells for $60, and the Deluxe set sells for $75. The variable expenses associated with each set are given below.
Standard Deluxe
Variable production costs . . . $15.00 $30.00 Sales commissions (15% of sales price) . . . . $9.00 $11.25
The company’s fixed expenses each month are:
Advertising . . . $105,000 Depreciation . . . $21,700 Administrative . . . $63,000
Mary Parsons, the financial vice president, watches sales commissions carefully and has noted that they have risen steadily over the last year. For this reason, she was shocked to find that even though sales have increased, profits for the current month—May—are down substantially from April.
Sales, in sets, for the last two months are given below:
Standard Deluxe Total
April . . . . 4,000 2,000 6,000 May . . . . 1,000 5,000 6,000
Hawaiian
Fantasy
Tahitian Joy Selling price per unit. . . . $15 $100 Variable expense per unit . . . . $9 $20 Number of units sold annually. . . . 20,000 5,000
Required:
1. Prepare contribution format income statements for April and May. Use the following headings:
Standard Deluxe Total
Amount Percent Amount Percent Amount Percent
Sales . . . . Etc. . . . .
Place the fixed expenses only in the Total column. Do not show percentages for the fixed expenses.
2. Explain the difference in net operating incomes between the two months, even though the same total number of sets was sold in each month.
3. What can be done to the sales commissions to improve the sales mix?
a. Using April’s sales mix, what is the break-even point in dollar sales?
b. Without doing any calculations, explain whether the break-even point in May would be higher or lower than the break-even point in April. Why?
PROBLEM 5–29 Changes in Cost Structure; Break-Even Analysis; Operating Leverage; Margin of Safety LO5–4, LO5–5, LO5–7, LO5–8
Morton Company’s contribution format income statement for last month is given below:
Sales (15,000 units × $30 per unit) . . . $ 450,000 Variable expenses. . . 315,000 Contribution margin . . . 135,000 Fixed expenses . . . 90,000 Net operating income. . . $ 45,000
The industry in which Morton Company operates is quite sensitive to cyclical movements in the economy. Thus, profits vary considerably from year to year according to general economic con- ditions. The company has a large amount of unused capacity and is studying ways of improving profits.
Required:
1. New equipment has come onto the market that would allow Morton Company to automate a portion of its operations. Variable expenses would be reduced by $9 per unit. However, fixed expenses would increase to a total of $225,000 each month. Prepare two contribution format income statements, one showing present operations and one showing how opera- tions would appear if the new equipment is purchased. Show an Amount column, a Per Unit column, and a Percent column on each statement. Do not show percentages for the fixed expenses.
2. Refer to the income statements in (1). For the present operations and the proposed new opera- tions, compute (a) the degree of operating leverage, (b) the break-even point in dollar sales, and (c) the margin of safety in dollars and the margin of safety percentage.
3. Refer again to the data in (1). As a manager, what factor would be paramount in your mind in deciding whether to purchase the new equipment? (Assume that enough funds are available to make the purchase.)
4. Refer to the original data. Rather than purchase new equipment, the marketing manager argues that the company’s marketing strategy should be changed. Rather than pay sales commissions, which are currently included in variable expenses, the company would pay salespersons fixed salaries and would invest heavily in advertising. The marketing man- ager claims this new approach would increase unit sales by 30% without any change in selling price; the company’s new monthly fixed expenses would be $180,000; and its net operating income would increase by 20%. Compute the company’s break-even point in dol- lar sales under the new marketing strategy. Do you agree with the marketing manager’s proposal?
PROBLEM 5–30 Graphing; Incremental Analysis; Operating Leverage LO5–2, LO5–4, LO5–5, LO5–6, LO5–8 Angie Silva has recently opened The Sandal Shop in Brisbane, Australia, a store that specializes in fashionable sandals. In time, she hopes to open a chain of sandal shops. As a first step, she has gathered the following data for her new store:
Sales price per pair of sandals . . . $40 Variable expenses per pair of sandals. . . 16 Contribution margin per pair of sandals . . . $24 Fixed expenses per year:
Building rental . . . $ 15,000 Equipment depreciation. . . 7,000 Selling . . . 20,000 Administrative . . . 18,000 Total fixed expenses . . . $ 60,000 Required:
1. What is the break-even point in unit sales and dollar sales?
2. Prepare a CVP graph or a profit graph for the store from zero pairs up to 4,000 pairs of sandals sold each year. Indicate the break-even point on your graph.
3. Angie has decided that she must earn a profit of $18,000 the first year to justify her time and effort. How many pairs of sandals must be sold to attain this target profit?
4. Angie now has two salespersons working in the store—one full time and one part time. It will cost her an additional $8,000 per year to convert the part-time position to a full-time position.
Angie believes that the change would increase annual sales by $25,000. Should she convert the position? Use the incremental approach. (Do not prepare an income statement.)
5. Refer to the original data. During the first year, the store sold only 3,000 pairs of sandals and reported the following operating results:
Sales (3,000 pairs) . . . . $ 120,000 Variable expenses. . . . 48,000 Contribution margin . . . . 72,000 Fixed expenses . . . . 60,000 Net operating income. . . . $ 12,000
a. What is the store’s degree of operating leverage?
b. Angie is confident that with a more intense sales effort and with a more creative advertis- ing program she can increase sales by 50% next year. Using the degree of operating lever- age, what would be the expected percentage increase in net operating income if Angie is able to increase sales by 50%?
PROBLEM 5–31 Interpretive Questions on the CVP Graph LO5–2, LO5–5
A CVP graph such as the one shown below is a useful technique for showing relationships among an organization’s costs, volume, and profits.
7
9 6
3 1
2
5 4 8
Required:
1. Identify the numbered components in the CVP graph.
2. State the effect of each of the following actions on line 3, line 9, and the break-even point. For line 3 and line 9, state whether the action will cause the line to:
Remain unchanged.
Shift upward.
Shift downward.
Have a steeper slope (i.e., rotate upward).
Have a flatter slope (i.e., rotate downward).
Shift upward and have a steeper slope.
Shift upward and have a flatter slope.
Shift downward and have a steeper slope.
Shift downward and have a flatter slope.
In the case of the break-even point, state whether the action will cause the break-even point to:
Remain unchanged.
Increase.
Decrease.
Probably change, but the direction is uncertain.
Treat each case independently.
x. Example. Fixed expenses are reduced by $5,000 per period.
Answer (see choices above): Line 3: Shift downward.
Line 9: Remain unchanged.
Break-even point: Decrease.
a. The unit selling price is increased from $18 to $20.
b. Unit variable expenses are decreased from $12 to $10.
c. Fixed expenses are increased by $3,000 per period.
d. Two thousand more units are sold during the period than were budgeted.
e. Due to paying salespersons a commission rather than a flat salary, fixed expenses are reduced by $8,000 per period and unit variable expenses are increased by $3.
f. Due to an increase in the cost of materials, both unit variable expenses and the selling price are increased by $2.
g. Advertising costs are increased by $10,000 per period, resulting in a 10% increase in the number of units sold.
h. Due to automating an operation previously done by workers, fixed expenses are increased by $12,000 per period and unit variable expenses are reduced by $4.